When it comes to your loans, are you always working to pay them off?
What if you were rewarded for taking out a loan?
Today, we cover three common types of loans:
mortgages, lombard loans and structured loans.
Let's start with mortgages. We've all grown up
hearing about them - in fact, as far as loans go, mortgages are a household name.
We all know that a mortgage is simply a loan that allows you to buy a house
or property - to live in, holiday in, work in or to rent out for income.
So how do you persuade somebody to lend you this money?
With a mortgage you're pledging the real estate as collateral
for the money to help you buy it.
Collateral is what the bank or the lender needs as security
in return for the risk of lending you the money.
Basically, it provides a guarantee
that they can take ownership of the real estate if you fail to pay back the loan.
It also works to your advantage because without collateral, the lender would have
to charge you a much higher interest rate to cover their risk.
A mortgage is a leveraged investment, which means that the higher the borrowing,
the higher the potential return, but also the higher your risk.
Imagine you buy a property for one million Swiss francs,
but you decide to only invest 250'000.
This means your mortgage is for 750'000.
Let's say you're very lucky and the property's value
increases to two million in 10 years.
In this case, your profit would actually be 100'000 francs per year,
which equals 40% of your initial investment of 250'000.
Of course, you have to deduct the interest rates you pay for the mortgage,
but in the current low interest rate environment, your return would still be
much higher than if you had invested one million out of your own pocket.
In that case, the yearly return would have
only been 10%, or 100'000 out of the one million.
So there's pretty much a big world of difference
if you're receiving a return of 40% versus 10%.
This is an example of the power of leveraging,
which is heightened by the current low interest rate environment.
However, the scenario can also have a different outcome.
If the real estate market slumps during this 10 year period,
then the property's value would decrease and you could be forced by the lender
to reduce your actual mortgage down to a reasonable loan-to-value level.
This is known as a "margin call".
Now, if you understand the basics of mortgages,
then you're on the right path to understanding Lombard loans.
Both types of loans rely on leveraging
your capital as efficiently as possible for the best outcome.
They are also both secured using collateral.
While real estate is the collateral
for a mortgage, lombard loans are secured with a securities portfolio.
That's a fitting name, right?
Securities for lombard loans can be equities,
bonds, investment funds or even structured products.
As long as they're listed and liquid,
it doesn't matter what type of security they are.
Pledging your securities as collateral means they don't need to be sold.
This is a pretty cool benefit.
You basically get to keep your assets
while you gain financial flexibility through new liquidity.
That's why we call a lombard loan:
a multipurpose loan which grants you full flexibility.
A first example for how you can benefit
from lombard loans is for an individual or for commercial enterprise purposes.
Let's explore what that looks like in real life.
Say you're an entrepreneur and you wish to grow your business.
Maybe you found a third party that's willing to finance that expansion.
However, you need additional funds today,
since the money from the third party will only be provided in the medium term.
That's where lombard lending comes in handy.
Or maybe you'd like to purchase a second home abroad where it's a bit difficult,
expensive or time-intensive to get financing for the property itself.
With the proceeds from a lombard loan, you can purchase or refinance a property.
Let's take the two examples I just mentioned before
and see how lombard loans are quite flexible.
Perhaps you intended to finance business expansion,
but you actually end up purchasing a home abroad instead.
With lombard loans, the funds are totally at your discretion
for the duration of the loan, which means that you can rethink
and change what you use the funds for as you need.
Just keep in mind that like any investment,
potential rewards come with potential risk.
Compared to other types of lending,
lombard loans depend on and hence are exposed to fluctuations in value of your
securities portfolio, given their market, credit, and liquidity risk.
Let's now turn to a more complex option for lending: structured finance.
Structured finance mechanisms are the ideal solution
when standard processes and policies just simply don't cut it.
It's a bit like building a custom designed house.
You create what you want, but you need to make sure that everything is in place.
So if we stick to this metaphor, the blueprint for your home relies heavily
on one key element: whether the collateral you've pledged,
if any, comes from listed securities or private assets.
This collateral is like the foundation that underpins your home.
Its exact properties, such as risk profiles, for example,
can inform what type of construction can be built.
What's key to know is that listed assets are by nature typically easier
to liquidate than private assets, which require a much more complex approach.
Let's take a real life scenario.
As an entrepreneur, perhaps you're the majority owner in your business.
Luckily, the company is valued at
ten billion Swiss francs.
So you're quite wealthy on paper,
but unfortunately, your account holds very limited liquid assets.
This is something that happens quite often:
equity rich, but liquidity poor shareholders of unlisted companies
who are looking to monetise against their private shares.
We call this cash-flow backed lending where
people monetise against their private shares by using them as collateral.
That's where a structured finance opportunity comes in handy for you.
The customised and flexible nature of structured finance means it's possible
to bundle different types of collateral into one facility, such as, for example,
listed securities, real estate, alternative assets or private shares.
This is the beauty behind structured finance, but it can become really complex.
This is why it's not really an area
for off-the-shelf solutions, but really it comes down to determining
tailored solutions for each person's exact financial situation.
So at the end of the day, it's clear that securing the correct loan structure
can provide you with financial gain and flexibility.
However, on the flip side, if you pick the wrong lending structure,
this can limit you in terms of liquidity and expose you to unnecessary risk.
Getting this balance right means
transparency about your financial situation.
This clarity enables your lender to structure the best possible loans for you
because after all, loans are a way to make your money work harder for you.
Check out the Julius Baer website for more
resources on investing, wealth- planning and megatrends.